Mgt accounting

Unit - 1

Nature and scope of Management

Accounting

Meaning of Management Accounting

Management Accounting is the presentation of accounting information to management in

order to formulate the policies and assist in its day-to-day activities . In other words, it help the
management to perform all its functions including planning, organizing, staffing, directing and
control.

Definition of Management Accounting

The Institute of cost and Management Accountants, London, has defined Management
Accounting as, "the application of professional knowledge and skill in the preparation of
accounting information in such a way as to assist management in the formulation of policies
and in planning and control of the operation of the undertaking."

According to R.N Anthony, " Management Accounting is concerned with accounting

information that is useful to management

Objectives of Management Accounting

The objectives of management accounting are as follows:

(i) To present financial information to the management in a way that is easily understandable

(ii) To supply necessary data to the management for formulating future plans. The data includes
statements pertaining to past results and estimates for the future.

(iii) To help in keeping the actual performance as per the plans made by the management.

(iv) To establish a strong, working relationship amongst different individuals pertaining to

different departments, of the same organization.

(v) To maximize the wealth of the organization

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(Vi) To motivate the employees, by fixing targets and providing incentives“

(Vii) To keep the tax burden of the organization minimum

(viii) To keep the management fully informed about the latest position of the organisation

Nature of Management Accounting

(i) Mainly concerned with future : Planning is the process of looking ahead by taking the
reference of the past. The process of management accounting is driven towards the future
course of action with proper planning based on the analytical financial details other past. It
considers the budgets to forecast the future revenue and expenditure and inflow and out
follow of funds.

(ii) Recent origin: Management accounting has been well recognized in the modern business
houses due to increasing customer base and market complexity. Modern managerial decisions
need much quantitative organized information rather traditional form of financial statements
for making effective decisions.

(iii) Management need oriented: Management Accounting is highly personalized service and
Subjective in nature. It is basically intended for the use of internal managerial decisions. It
provides necessary information as per the need of the management in therequired format and
ensures that the information’s are sufficient to make effective decisions.

(iv) Information as per Management need: There is no hard and fast rule in the preparation of
management reports and statement, it always as per the situationalrequirement of the
management and based on the availability of the data for analysis and interpretation.

(v) Provides data and not the decisions: Management accounting discipline is not an
replacement of management. It provides just information to the managerial decisions. It
facilitates decisions since majority of the decisions are made considering the facts and figures
provided by the management accountants. But at the same time these data itself cannot form
the decisions of the management.

(vi) Objective oriented: Management accounting present data in such a way that it enables the
management to formulate policies and programme so as to achieve the managerial or
organizational goals in most efficient and effective manner.

(vi) Financial and cost accounting information: Management accounting is all about the analysis

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and interpretation of financial and cost accounting data, to generate such reports and
statements which can prove useful to management in decision making.

(vii) Increases efficiency: Management accounting is concerned with providing, the needed
information to the Management in the proper manner and assisting in the policy formulation
and managerial control. This enables the management to increase efficiency of its operation
and ensures the optimum profits with minimum operational risk

Apart from the above unique features Management Accounting is also characterized by the
following:
a) It does not follow any fixed norms or formats.
b) Basically concerned with forecasting
c) Mainly used for Internal purpose.
d) Useful in managerial decision making.
e) It is not compulsory as the any other disciplines like financial accounting and cost accounting.
It is purely optical to the management .
f) It is an interdisciplinary subject since it mainly depends on the financial and cost accounting

Scope of Management Accounting

(i) Financial Accounting : Accounting is the process of systematic recording of financial

transactions so as to determine the true and fair financial position of a concern.
Management accounting derives the necessary data from the financial accounting. For instance
when fund flow statement or Ratio statement are to be prepared, financial statements are very
essential without which the preparation and decision about fund flow and ratios are not
possible.

(ii) Cost Accounting: Management accounting uses certain technique and tools of cost
accounting as well. Cost accounting provides the various techniques of costing, viz, Marginal
Costing, Standard Costing, Differential Cost Analysis etc. which plays significant role in the
operation and control of the enterprise It assists management in measuring the operational
efficiency of the management and achieving managerial goals.

(iii) Budgetary Control: Budgetary control is a system of controlling Costs thorough

establishment of standards. It controls the activities of the business and measures the variance
by comparing the actual with the budgeted figures and enquires into the reasonsof such
variance at each and every step, so that the adverse variance may not be repeated in future.

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(iv) Tax Planning: It is concerned with the computation of taxable income according to Income-
Tax Act, and filing of returns and the payment of tax. It is one of the core functions of the
modern management accountant, facilitating management in proper tax planning and
accounting.

(v) Analysis and Interpretation of Accounts: Financial statement can be better understood
through comparative study. The primary duty of the managementaccountant is to explain the
data relating to the management and assist management in taking decisions.

(vi) Reporting: Management accounting uses the technique of statistics wherever necessary for
effective analysis and interpretation. Sometimes reports on various aspects of the business are
to be submitted by the management accountants. At the time of preparation of the statement
or Repots, they use different statistical techniques, viz, Line Chart, Pie Chart, Index Numbers
etc. in order to be more attractive and intelligible.

(vii) Internal audit and control: Management accountants depend on the internal audit and use
that for generating reports on various financial issues for decision making.

(viii) Budgetary Control: Budgetary control is a system of controlling costs thorough

establishment of standards. It controls the activities of the business and measures the variance
by comparing the actual with the budgeted figures and enquires into the reasons of such
variance at each and every step, so that the adverse variance may not be repeated in future.

(ix) Tax Accounting : It is concerned with the computation of taxable income as per Income Tax
Act, and filing of returns and the payment of tax. It is one of the core functions of the modern
management accountant, facilitating management in proper tax planning and accounting.

(x) Analysis and Interpretation of Accounts: Financial statement can be better understood
through comparative study. The primary duty of the management accountant is to explain the
data relating to the management and assist management in taking decisions.

(xi) Management Information System: It is very difficult to imagine organisations without

computers in the globalized corporate environment. Information’s are stored and supplied to
the management with the help of computers for managerial decisions. The advancement in the
technology has made management accountants job much easier and effective and has made
more depended on the technology from time to time.

Tools and Techniques used in Management Accounting

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The important tools and techniques are briefly explained below.

1.Financial Planning
The main objective of any business organization is maximization of profits. This objective is
achieved by making proper or sound financial planning. Hence, financial planning is considered
as best tool for achievingbusiness objectives.

2. Financial Statement Analysis

Profit and Loss account and Balance Sheet are important financial statements. These
statements are analyzed for different period. This type of analysis helps the management to
know the rate of growth of business concern. This analysis is done through comparative
financial statements, common size statements and ratio analysis.

3. Cost Accounting
Cost accounting presents cost data in product wise, process wise, department Wise branch wise
and the like. These cost data are compared with predetermined one. This comparison of two
costs enables the management to decide the reasons responsible for the difference between
these costs.

4.Fund Flow Analysis

This analysis find out the movement of fund from one period to another. Moreover, this
analysis is very useful to know whether the fund is properly used or not in a year When
compared to the previous year. The working capital changes and funds from operation are also
find out through this analysis.

5.Cash Flow Analysis

The movement of cash from one period to another can be find out through this analysis.
Besides, the reasons for cash balance and changes between two periods are also find out. It
studies the cash from operation and the movement of cash in a period.

6. Standard Costing
Standard costing is predetermined cost. It provides a yard stick for measuring actual
performance. It is used to find the reasons for the deviations if any.

7.Marginal Costing
Marginal costing technique is used to fix the selling price, selection of best sales mix, best use of
scarce raw materials or resources, to take make or buy decision, acceptance or rejection of bulk

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order and foreign order and the like. This is based on the fixed cost, variable cost and
contribution.

8.Budgetary Control
Under Budgetary control techniques, future financial needs are estimated and arranged
according to an orderly basis. It is used to control the financial performances of business
concern. Business operations are directed in a desired direction.

9. Ratio Analysis
It is used to management in the discharge of its basic functions of forecasting, planning,
coordination, communication and control. It paves the way for effective control 0f business
operations by undertaking an appraisal of both the physical and monetary targets

10. Revaluation Accounting

The fixed assets are revalued as per the revaluation accounting method so that the capital is
properly represented with the assets value. It helps to find out the fair return On capital
employed.

11.Decision-making Accounting
A business problem can be solved by choosing any one of the best and most profitable
alternative. To select such alternative, the relevant costs are compared. Thus, accounting
information are used to solve the business problem which are arising out of increasing
complexity of nature of business.

12.Management Information System

The free flow communication within the organization is essential for effective functioning of
business. Hence, the management can design the system through which every employee of an
organization can assess the information and used for discharging theirduties and taking quality
decisions.

Difference between Financial Accounting and Management Accounting

Basis Financial accounting Management Accounting

Users Mainly intended to serve external users Mainly intended to serve internal
like share holders, bankers, creditors and users like management
government.
Legality Statutorily compulsory as per different Not compulsory
acts such as companies act of 1956
income tax act of 1961etc.
Development It is well developed and very old system It is of recent development
in practice

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Subject matter It deals With preparation of financial
statements through systematic recording
and determines the financial position of a
concern.
Standard There is specific standard for Preparation
as per the act and reports are practice.
Dependency It is an independent discipline . discipline.
Publications It is compulsory to publish the financial
reports of the concern.
Statement and report Generally Trading and profit and loss
prepared account and balance sheet areprepared
Consideration It considers only monetary transactions.
Auditing Audit of books of accounts by a qualified
charted accountant iscompulsory
Difference between Cost Accounting and
Management Accounting
Basis Cost Accounting
Functions Basically executes the function of
identification and recording of cost and
cost control in the operation.
It is necessary to maintain cost records
in a systematic way in certain
Statutory compulsions . manufacturing industries asper the
notification of the notification
Focus It is focused on cost identificationand
cost control.
Users of the information It is used by both internal as well as
external parties.
Data used It derives certain data from financial
records.
Scope and coverage The scope of this discipline is limited to
the extent of cost recording and
reporting
SN
It deals with presentation of needed
information for management for
effective decisions.
Preparation of statements and
reports are not standardized
It is an inter dependent.
It is not compulsory.
It prepares the funds and cash flow
statement, budgetary reports, ratio
statements etc,
It sometime considers non monetary
aspect also like quality, machine
hours, number of people working etc.
It is not necessary to getaudited the
records of management accounting,
Management Accounting
It basically assists management in
decision making through providing
necessary information.
It is purely optional to management
It is focused on the effective
decisions for optimum managerial
efficiency and objective attainment.
Used by only internal parties.
It derives data from financial books,
cost books as well as certain other
sources.
The scope of this discipline is
broader and covers various aspects
like finance, costing, taxation, audit
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and investments
Tools and techniques It follows well developed tools and It doesn’t have well developed tools
used techniques for identification and or technique.
recording of cost.

Differences between Financial Accounting and Cost Accounting

Basis Financial accounting Cost accounting

1. Purpose It serves the interest of business and
other interested parties by Providing
suitable information in the financial
statements.
2. Options F A is required to be kept as per the
requirements Of the company act and
income tax act.
3. Analysis FA reveal the profit of the business as
a whole.
4. Recording It consists of classification recording
and analysis of transaction in a
subjective manner i.e., according to
the nature of expenditure.
5. Control It lays emphasis on the recording
aspect, no consideration is given to
control aspect.
It involves reporting of
6. Reporting business performance at the end of
the accounting year.
7. Obligation This is to be maintained compulsory.
It renders information for the
guidance of the management for the
proper planning control and decision
making.
CA is voluntarily kept to serve the
management in the discharge of
management functions.
CA shows the profit result of each
business as a whole operations
process and product
It records in an objective manner i.e.,
according to which cost are incurred
It provides for a detailed system of
control with the help of standard
costing and budgetary control.
There is a continuous flow of data
information of cost report to
management.
This is to be maintainedvoluntarily.

8.Audit Audit of FA is statutory Audit of CA is not compulsory.

9. Duration of FA provides financial information once CA furnishes reporting cost data at

a year. frequent intervals.
10. Pricing It fails to guide the formulation of It provides adequate data for
pricing policy. formulating pricing policy.
11. Valuation of Stock Stock is valued at cost or marked rice Stock is always valued at cost price.
whichever is less.

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Limitations of Management Accounting

1. Data Dependency

Management accounting derives information from Financial accounting, Cost accounting and
other sources. So, the conclusions arrived at by management accountants depend to a large
extent on the accuracy of these two (Financial accounting and Cost accounting) records.
Therefore, if the past data which are collected from the financial and cost records are found
inaccurate, the decisions suggested by the management accountants, on the basis of the above,
also will be inaccurate.

2.Does not give the decision

Management accounting cannot replace the decisions. It can just assist the management in its
operations through providing necessary analytical statements and advises management for
better and efficient managerial functions.

3. Costly affair

Installation and maintenance of Management accounting system is suitable for those concerns
which has significant amount of transactions generally large establishments. before, small
concerns cannot afford to adopt this system.

4. No standardization as other disciplines

Management accounting is still in the development stage. So it has to face the problems fluidity
of concepts, improvement of techniques etc. It does not have any strong principles like financial
accounting and cost accounting. It does not follow any set rule and hence differs in its practices.

5. Danger of misleading
The information Provided by Management accountants cannot be taken as full proof
information for making any managerial decisions. Because the data used by
managementaccountants itself may have window dressed data due to which the management
accounts may mislead the management.

6. Needs human involvement for interpretationManagement accounting involves people to

make final reports or interpretations, due to which the interpretation may be of the personal
opinion of the person Who has prepared it.
It creates differences in the interpretations and becomes more subjective rather than objective
in the analysis

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Unit - 2

FINANCIAL STATEMENT ANALYSIS

Meaning of Financial Statement

Financial statements are the essential documents of business. They are the outputs of financial
accounting. They are the final products of the accounting process. They are statements
containing financial information of a business enterprise. They convey certain message to feel
financial pulse of an organization. The basic purpose of preparing financial statements is to
convey information about financial position of the enterprise to owners, creditors and the
investors.

Objectives of Financial Statements

Financial statements serve as a horoscope of a business. This is so because they enable readers
to measure financial position of a concern. The main objective of financial statements is to
provide information about the financial position and performance of an enterprise that is useful
to users in making decisions. The other objectives are summarized below:

1 To provide information about assets and liabilities of a firm.

2 To provide useful information to various parties interested in financial statements

3 To present true and fair view of the business.

4. To estimate the earning capacity of the enterprise.

5 To determine the debt capacity of the concern.

6. To decide about the future prospects of the business.

Thus, the ultimate Objective of financial statements is to get better insight about the financial
strengths and weakness of the firm.

Nature of Financial Statement

The following characteristics of financial statements indicate their nature:

1. Recorded Facts
The term recorded facts refers to the data drawn from accounting records. Only those facts
which have been recorded in the books are shown in the financial statements.

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2. Accounting Principles
In the preparation of financial statements, certain accounting principles, concepts and
conventions are followed. For example: The principle of cost price or market price whichever is
less is followed for valuation of stock.

3. Assumptions
Business transactions are recorded on certain assumptions. For example: In preparing financial
statements, the accountants make many assumptions like that the value of money remains
constant, going concern concept etc.

4. Personal Judgment
The financial statements are affected by the personal judgment of accountants. For example:
The method of stock valuation, method of depreciation etc. depend on the personal judgment
of the accountant. The accountant can select one of the available methods of stock valuation,
depreciation etc.

Essential of Financial Statements

The financial statements should possess the following essential qualities:

1. Understandability
Financial statements should be easily understandable by users. For this, the information
contained in these statements should be clear and simple.

2. Relevance
The financial statements must contain only relevant information. Then only the users can
evaluate past, present and future events and can take wise decisions.

3. Reliability and Accuracy

Financial statement should disclose information in such a way that the users can compare the
current year’s progress with that of previous year. Users must also be able to compare the
financial performance of reporting company with that of other companies.

4.Comparability

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Financial statements should disclose information in such a way that the users can compare the
current year’s progress with that of previous year. Users must also be able to comparethe
financial performance of reporting company with that of other companies.

5.completeness

the information contained in the financial statements should be complete in all respects. This
means all information should be shown in these statements. It further means that the
information shown in the financial statements should not mislead creditors, investors and other
users.

6.Timeliness

The financial statements should be prepared within a reasonable time after the accounting
period is over. If the statement are not prepared and presented in time, they cannot be
properly used. Beside, the firm cannot formulate plans for future.

Meaning of Analysis and Interpretation of Financial Statement

The term "analysis" can be understood as the process of splitting the facts or data found in the
financial statements into simple elements. The term "interpretation" can be understood as the
explanation of the meaning and significance of the financial data, so simplified with a view to
throw light on the profitability and financial position of an enterprise.

In the word of Myers, "Financial statement analysis is largely a study of relationship among the
various financial factors in a business as disclosed by a single set of statements, and a study of
the trend of these factors as shown in a series of statements".

Types of Financial Statement Analysis

1. on the basis of modes operating

a) Horizontal Analysis: Financial analysis is done for number of years, it is known as horizontal
analysis. Such analysis set a trend wherein the figures of various years are compared with base
year. Decision based on the trend percentage example: Trend percentage and Comparative
financial statement.

It is also known as dynamic analysis as it measures the change of position of the business over a
number of years.

b) Vertical Analysis: Analysis is made for data covering one year’s periods it is known vertical

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analysis. Example: Ratios and Common size financial statement

It is also known as static analysis as it measures the statement of affairs of the business as on
given period of time.

2. On the basis of material used

a) External Analysis: Financial statements analysis is made by outsiders who have no access to
the books of accounts they have depend on the published accounts. Example: Shareholders,
Creditors, Government agencies etc.

b) Internal Analysis: Financial statements analysis is made by internal parties who have access
to the books of accounts such as management, employees etc.

Types of Analysis and Interpretation of Financial Statements

Financial Statements can be analyzed by using the any one of the following method.

1. Comparative financial statement analysis.

2. Common-size statement analysis.

3. Trend analysis

4. Ratio analysis.

5. Fund flow analysis.

6. Cash flow analysis.

comparative Financial Statements

Under this method the financial statements of the different period of the same concern will be
compared in order to derive significant change in the financial and profitability position of the
concern. It denotes the changes (i.e increase or decrease) in the financial figures between two
or more years, in terms of money value and as well as in term of percentages. In other words,
they are those financial statements which summarizes and present relative accounting data for
a number of years, incorporating therein the changes in individual items of accounting figures.

Comparative Statement Analysis can be :

(i) Comparative Income Statement Analysis

(ii) Comparative Balance Sheet Analysis

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Objectives or Purposes of Comparative Financial Statements

1. To make the data simpler and more understandable.

2. To ascertain the changes occurring year by year in financial position and performance of the
enterprise.

3. To find out the strength and weakness of liquidity, solvency and profitability.

4. To help the management in forecasting and planning.

common-size Financial Statements Analysis

In Common-size financial statements the data or figures presented in the statements are
converted into percentages, taking some common base. The total of Assets or, Liabilities and
capital is taken as 100% and all the items in the balance sheet are expressed as a percentage of
this total. In case of the common size income statement, the Net sales figure is taken as 100%
and all other items of the income statement are expressed as a percentage of Net Sales.

common-size financial statements mainly include;

1. Common-Size Income Statement and

2. Common-Size Balance Sheet

Common-size Income Statement

In case of common size income statement, the net sales figure is taken as 100% and all other
items of the income statement are expressed as a percentage of Net Sales. It enables to know
relative contribution of each element of the income statement on sales and profit of the
concern. It also facilitates for the effective controlling of the operations so as optimize
thereturn on investments.

Trend Analysis

Sometimes, it becomes necessary to known the trend changes in the financial position of the
concern When a concern needs to know the profitability trend of the organization only profit
and loss account independently may not serve the purpose. In such case, it is necessary to
prepare a statement of the profit or loss or Balance sheet for many years and taking any
previous year as base the trend or changes in the financial position can be prepared. When the
financial statements of a number of years are analyzed, the analysis is called trend analysis

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It is also called as horizontal analysis since it is prepared for many years taking any previous
year as base year. In other words, horizontal analysis is a type of analysis in whichthere is
comparison of the trend of each item in the financial statements over a number of years.

Trend analysis as a tool of Decision-making

Statement of trend analysis helps in many managerial decisions. It enables to find Out the
growth or decline percentage or the pattern of changes that are taking place in an
organization. It enables managers to take necessary measures to curb the unhealthy trends in
the organisations. It is also useful to investors, Bankers and creditors to make effectivefinancial
decisions on the company. Its uses is outlined below:

(i) Sales trend in the organization can reflect on the efficiency of the sales department.

(ii) Sales trend enables management to take necessary steps wherever required to improve the
overall operational efficiency.

(iii) Trend on cost of operation facilitates to take decisions on cost control and improving
profitability.

(iv) Trend in the profitability reflects the overall efficiency of the organization in utilizing its
resources and optimizing the return on investments.

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UNIT VI

MANAGEMENT REPORTING

INTRODUCTION

The words report denotes a form of upward communication as the term ‘report’ is normally
used for formal communication providing the relevant information about the performance of
functional areas of the organization by a lower level to a higher level of authority on the other
hand the word communication refers to form of downward communication i.e. from higher
level to lower level.

Meaning and Definition of Management Reporting

Management reporting is refers to a system of communication, normally in the written form, of

facts which should be brought to the attention of various levels of management who use them
to take suitable action.

According to R.L Smith reports may be defined as” Instruments of communication the nervous
system of organizational anatomy. Accounting reports consists of financial data and may take
the character of draft, schedules, statements, charts, graphs, diagrams and any other statistical
presentations”

Methods of reporting

Management reporting is always need based. It takes a form as per the situational need of the
organization. Reports to the management may be presented in the following forms.

1. Written reporting
2. Oral reporting
3. Graphic reporting

1. Written reporting –These are formally presented in writing. This is the most common
mode of reporting. It may be in form of letter, circular or manual. It facilitates for easy
reference and act as an evidence or support for managerial decisions. It creates record
for the organization in support of decisions. These include,
a. Balance sheet
b. Fund flow statement
c. Cash flow statement
d. Sales reports

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e. Performance reports of the departments

f. Ratio analysis reports
g. Budgetary reports etc.
2. Oral reporting –These are presented in a discussions or dialogue form. Such
presentation of information is more informative and can clarify many aspects through
the person who is presenting the report. It is helpful only to a limited extent and does
not act as an evidence or support for managerial decision in the later dates. It includes,
a. Group meetings
b. Conferences with individuals
c. Interviews
3. Graphic reporting –The reports may be presented in the form of charts, diagrams and
pictures. These reports have the advantages of quick grasp of trends of information
presented. A look at the chart or diagram may enable the reader to have an idea about
the information. In the modern times graphs and charts are becoming more popular
mode of presenting any kind of information. This is the most effective medium of
reporting removes dullness and confusions which we usually find in other forms of
reporting. The following are the types,
a. Bar charts
b. Pie charts
c. Zee charts
d. Break-even point
e. Flow chart
f. Control chart
g. Progress chart

Requisites of a good reporting

Promptness –Submission of timely reports to management is an important requisite of

management reports as the management initiates the process of taking decision only on the
receipt of reports. Hence the system should ensure the preparation and submission of reports
to the management on time. If there is any delay in the submission of reports, it results in the
further delay in the decisions and cost.

Simplicity –A report should be simple and easy to understand. The presentation of operating
information should be simple and clear. This requires exact and simple definitions of financial
terms. Simplicity of reporting to top management can be attained by elimination of data using
schedules. The use of graphical devices makes it possible to indicate.

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Consistency –It is necessary to present the information in a consistent manner to the various
operating levels of management because very often, the same statistical data are compiled in
different needs to the top and lower management levels. In the absence of consistency, there
cannot be any proper comparison.

Comparability –The report should contain the information about both the budgeted
performance and actual performance for the reporting period. This is necessary to compare the
actual performance with the budgeted and to determine the deviation which is more useful for
managerial decisions. It also enables the management to take appropriate measures to improve
the corporate performance. Further the reports may also include the performance statistics for
the immediately preceding period so that management can ascertain whether the performance
has improved during current period when compared to the previous period.

Readability –It is another face of simplicity, which is of equal importance. The rounding off of
figures, for instance also helps in readability. Approximations can give better clarity to figures.

Updated –A report should be up to date. It must reflect the recent information of the concern.

Good Format –The effectiveness and usefulness of management reports depends upon the
format in which the reports are presents. Hence, the report to the management should have
proper format with suggestive title, heading, sub-heading, paragraph divisions, required
number of columns and rows with relevant captions etc. as the reports are sent to different
levels of management, the format of reports should be designed to suit the requirement of
respective levels.

Attractiveness and accuracy –A report should be accurate in its data presentation. It should
consist more tables, graphs charts and figures which can support for immediate attention and
speedy decisions.

Concise –A concise report is more appreciated by the managers. It saves time and facilitates for
fast decisions. However it should be covering all aspects are materiality significant for making
decisions.

Key factors –A report should highlight on the key aspects of the situation. It should catch the
attention of top level management on those factors which has significant effect on the
organization and which needs immediate action.

Principles of Exception –As the time and efforts of management are precious, it is not
necessary to draw the attention of management for all aspects. It is sufficient if the reporting
draws the attention of management only towards the exceptional aspects.

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Controllability –A good report must support for controlling the situations. It should prescribe
the standards, compare actual with the standards, should mention the variations and
suggestions to avoid unhealthy variations in the performances.

Kinds of reports

Managerial reports can be classified

1. On the basis of purpose of the management

2. On the basis of period of submission
3. On the basis of operations of the organization
4. On the basis of administrative needs of the management

1. Classification of reports according to the users or purpose or need or the situation

a. Internal reports –Reports prepared for the use of the internal people like director,
managers, supervisors etc. for the purpose of decision making is said to be internal
reports.
b. External reports–Reports prepared for the use of outsider is known as external
reports. Reports meant for persons outside the business, such as the government,
creditors, shareholders, banks and financial institutions, stock exchanges etc.
2. Classification of reports according to the period of submission
a. Routine reports–Reports prepared on a certain periods is said to be routine reports.
It covers the day to day aspects of the departmental activities.
b. Special reports –Special reports are those, which are prepared for the specific
purpose. It is generally situation based. For instance, when there is a drop in sales of
a brand in a particular market a report probing into the reasons for such fallis known
as special report.
3. Classification of reports according to the function or operation
a. Functional reports –Functional or operating reports are reports which provide
information about the operations at different functional levels of the concern.
b. Financial reports–It is a report on financial performance of a concern on given
accounting date. It provides useful information about the financial position of the
concern. It includes financial statements like balance sheet, cash flow statement,
fund flow statement, income statement etc.
4. Classification of reports according to the administrative needs
a. Enterprise report – It is a report, which gives detailed information of an enterprise
since its inception. Example-balance sheets, employment reports, income tax
returns etc.

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b. Control report –These are part of management control process. The information
contained in these reports will be elaborate and comparative in nature. The actual
performance of a unit is compared with its prescribed standard and highlights the
variations of their performances.
c. Investigative report–These are also known as special purpose reports. Whenever
management feels that a special or detail prove into the activity or performance of a
unit is needed it can form a committee to prove into such matter and present a
report. Such reports are known as investigative reports.

Drafting reports under different situations

Situation 1

As an accountant of Banashankari Company Ltd Tumkur, draft a report to be submitted to the

managing director, regarding the decline in sales and also your suggestions to remove such decline

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Date1-2-2019

From

The Accountant

Banashankari Company Ltd

Tumkur -572102

To

The Managing Director

Banashankari Company Ltd

Tumkur -572102

Respected sir,

Sub: Report on decline in sales

In accordance with your instruction, I have enquired the causes of declining in sales in the last
three years to till January 2019 and submit my report as follows.

1. The new companies in the market who are in the same line of business have come out with
artistically designed products with variety of colors and sizes.
2. Many of our competitors are selling the products at cheaper rate than us.
3. After sales services of our company is not as good as of competitors.
4. Many of our products are not customer oriented.
5. Lack of proper promotion at retails.

Suggestions for improvement of present situation:

1. Efficient designers should be appointed to develop attractive products.

2. It is necessary to fix competitive prices in order to attract the customers.
3. It is necessary to develop proper relationship with requirement and preferences of sale service
to the customers.
4. Products should be produced according to the requirements and preferences of customers.
5. Effective promotion strategy is to be taken at retail level.

Yours faithfully

Accountant

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Situation 2

Prasanna Co Ltd. Is facing acute shortage of working capital. Draft report to the top management
stating the reasons for shortage and suggest the sources of securing the working capital.

Date 1-1-2019

From

The Management Accountant

Prasanna Co Ltd

Tumkur -572102

To

The Management

Prasanna Co Ltd

Tumkur -572102

Respected sir,

Sub: Report for the reasons for shortage in working capital and suggestions for
corrective measures.

The company is facing shortage of working capital because of the following reasons which we
have arrived after investigation:

1. Excessive investment in fixed assets.

2. No proper and effective data collection measures.
3. Mismanagement of short term source of funds.
4. No proper selection of short term source of funds.

To overcome the above causes for declining in working capital, I would like to give the following
suggestions:

1. Investment in current assets and fixed assets should be well balanced.

2. Debt collection should be in time and it collection policy should be effective.
3. Short term source of funds should be properly and effectively used.
4. There should be proper selection in the source of securing working capital. Includes:
 Commercial papers

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 Indigenous bankers
 Trade creditors
 Accounts receivables –credit/factoring
 Commercial papers etc.,
Yours faithfully,
Management accountant

Situation 3

Radhika Company is facing the problem of raw materials shortage. As a management accountant you
are required to draft a report suggesting reformulation of purchase policy to have uninterrupted
supply of raw material.

From Date 1-12-2018

The Management Accountant

Radhika Company

Tumkur -572102

To

The Management

Radhika Company

Tumkur -572102

Respected sir,

Sub: Report for reformulation of purchasing policy

As basic input, raw materials are very essential for production, any short supply of raw materials
will seriously affect the production. Due to which the company is facing the following reasonable
problems.

1. The authority of purchase decision is not delegated properly to the purchase manager.
2. The company is not properly maintaining the re-order quantity level.
3. There is a lack of sufficient space for shortage of raw materials in stores department.
4. Finance policy is not favorable towards purchase policy.
5. The suppliers are situated very far away from company.

Suggestions for improvement of present situation:

1. Authority should be properly delegated to the purchase manager to take decision.

2. It is necessary to fix re-order level

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3. It is necessary to increase storage space in the stores department.

4. Finance policy should be liberalized towards purchase policy.
5. It is necessary to search for local suppliers, who are very near and who can supply quality of raw
materials at reasonable rates.

Yours faithfully

Management Accountant

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Unit 3

Ratio analysis

Meaning of ratio analysis

Ratio analysis is one of the important technique of financial analysis where ratios are used as a
yard stick for evaluating the financial condition and performance of a firm.

According to accountants hand book by Winson Kenn and Bed Ford “A ratio is an expression of
the quantitative relationship between two numbers”

Uses or advantages of ratios

1. It simplifies the financial statement.

2. It facilitates inter firm comparison.
3. It helps in planning.
4. It makes intra firm comparison possible.
5. The ratios can assist the management in its basic functions of planning, forecasting, co-
ordination, control and communication.

Classification of ratios

Various Accounting ratios can be classified as follows

1. Traditional ratios
2. Functional ratios

1. Traditional ratios: It consists of

a. Balance sheet ratios
b. Revenue sheet ratios or P&L A/c ratios
c. Composite or inter statement ratios
a. Balance sheet ratios: ratios calculate on the basis of the figures or information’s of
balance sheet only are known as balance sheet ratios. Example: current ratio, liquid
ratio, debt equity ratio etc.
b. Revenue sheet ratios or P&L A/c ratios: ratios calculated on the basis of the
information’s or the figures of profit and loss account are called revenue ratios or profit
and loss account ratios. Example: gross profit ratio, net profit ratio, stock turnover ratio
etc.

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c. Composite or inter statement ratio: ratios based on the figures of balance sheet as well
as the profit and loss account are known as composite ratio. Example: return on
proprietor’s fund, earning per share etc.
2. Functional ratios: on the basis of function or tests accounting ratios are broadly
classified as under.
a. Liquid ratios: It includes
 Short term solvency ratios
 Long term solvency and leverage ratio
 Activity ratio
 Profitability ratio etc.

Liquidity ratio refers to the ability of the concern to meet its current obligation as when they
arrives liquidity ratios are the ratios which measures the short term solvency of the firm.

The sufficiency or insufficiency of the current asset should be assessed by comparing them with
short term liquidity.

Significance of ratio analysis

1. It is an useful and important technique to check upon the efficiency with which working
capital is being used in the enterprise.
2. It helps in cost control.
3. It is a medium of communication of financial position of a concern.
4. It is very helpful in financial forecasting.
5. It facilitates for comparison.
6. Financial ratios are very helpful in the diagnosis and financial health of a firm.

Limitations of ratios

1. Ratios are based on many assumptions and hence these may mislead the decision
makers.
2. Ratios are meaningful only when they are studied with other ratios. A ratio alone cannot
be meaningless by itself.
3. Understanding of ratios needs professional knowledge. Hence, it cannot be used by
common people.
4. Ratios alone are not adequate for judging the financial position of a business.
5. Ratios will not give decisions: It is just information to make effective decisions.
6. There is no standardization in ratios.
7. Does not reflect the qualitative aspects.
8. It is based on financial statements.

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Unit 4

Fund flow statement

Meaning of fund

The term fund can be used in three different ways. They are:

In narrow sense: It means cash or money.

In broad sense: It means all financial resources.

In popular sense: In the context of funds flow statement, the term fund means working capital.
It is the excess of current assets over current liabilities.

Meaning of Fund Flow Statement

Fund flow statement is a statement in a summary form depicting the changes in the items of
financial position between two balance sheet dates and showing sources and application of
funds.

Objectives or purposes of Fund Flow Statement

 To know the changes in working capital during the period.

 To understand the working capital position of the firm.
 To assess the financial condition of the firm.
 To anticipate the working capital position.
 To reveal the most important changes those have taken place during a particular period.
 To provide a basis for budgeting.

Importance or uses or benefits of fund flow statement

1. Useful to share holders

a. It provides information regarding the availability of funds in the business.
b. It indicates the earning capacity of the business.
c. It enables to know the ability of the company to pay the dividend.
2. Useful to long term creditors and debenture holders
a. It helps to understand whether the money borrowed is utilized or not.
b. It enables to judge the capacity of the company to repay the loan or debentures.
3. Useful to short term creditors, banks and financial institutions
a. It helps to know whether the money borrowed is utilized or not.
b. It helps to know whether the company can pay interest and to repay the principal in
time.

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4. Useful to management
a. Planning temporary investment of funds.
b. Evaluating proper utilization of funds.
c. Formulating sound dividend policy.
d. Estimating future working capital requirement.
e. Testing whether working capital is effectively utilized.
f. Taking appropriate decisions regarding purchase of assets.
g. Identifying any necessary investment in fixed assets.
h. Understanding the reason for financial difficulties, if any.
i. Planning for redemption of long term debts.
j. Ascertaining funds from operation.

Limitations of fund flow statement

1. It shows what happened in the past. Hence, it is historical in nature.

2. It is only a rearrangement of data given in financial statements. Hence, it is not original.
3. It cannot reveal continuous changes.
4. It does not take into account those transactions which do not affect the working capital.
5. It is not as useful as cash flow statement.
6. It does not reveal the cash position of a firm.

Steps involved in preparation of Fund flow statements

Step -1 preparation of schedule of changes in working capital.

Step -2 prepare necessary ledger accounts to identify the hidden transactions from the non-
current assets and non-current liabilities.

Step-3 compute funds from operations from revenue expenses and incomes.

Step-4 preparation of Fund Floe Statement.

Treatment of special items

Proposed dividendIt may be treated as non-current liability .the proposed dividend for the
current year should be debited to Adjusted P&L A/c in order to find out funds from operation.
The dividend paid will be shown as application in fund flow statement. Dividend proposed in
last year is assumed to have been paid during the year.

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Dividend paid –Sometimes proposed dividend is not given in the balance sheet. But dividend
paid is given under adjustment. In such cases, it is added back to net profit while calculating
fund from operation. It should also be taken the fund flow statement as an application.

Interim dividend –It is always as additional information. It should be added back to net profit
while calculating fund from operation. It should also be taken as application in fund flow
statement.

Provision for taxation –It is treated as non-current liability. In this case, a ledger account is
prepared for this item in the work sheet, the closing balance figure (on credit side) being the
provision made during the year, should be taken to the debit side of ‘Adjusted P&L A/c’ for
calculating funds from operation. The amount of tax paid will be shown as application in the
Fund Flow Statement.

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Unit 5

Cash Flow Statement

Introduction

A cash flow statement is a statement which shows the change in cash position from one period
to other. This statement helps in short term financial planning.

Definition of cash fund

Cash

Cash comprises cash on hand and demand deposits with banks.

Cash equivalents

There are short term, highly liquid investments which can be readily converted into cash
without a decline in their value. Examples of cash equivalents are treasury bill, commercial
paper, short term deposits, marketable securities etc.

Cash flows

Cash flows are inflows and outflows of cash and cash equivalents. When there is a change in
any transaction, there will be flow of cash. If the effect of transaction results in increase of cash
and its equivalents, it is called an inflow. If it results in decrease of cash, it is called outflow.

Meaning of Cash Flow Statement

In the cash flow statement the term fund is used to mean cash only and does not include even
most liquid current assets. A cash flow statement shows the impact of transactions on cash
position of the firm and includes all transactions having a direct impact upon cash. It explain the
changes in cash position between two periods

Note: According to AS 3 (revised) all manufacturing and finance companies which are listed in a
stock exchange or all commercial or industrial and business enterprise whose sales are more
than 50 crores per year, must prepare and publish CFS by indirect method. This is made
compulsory from April 1, 2001 onwards.

Objectives of cash flow statement

1. Useful in cash planning: It is very useful to management by providing a basis to evaluate

ability of a company to generate cash. A cash flow statement prepared on an estimated
basis for the next accounting period enables the management to know how much cash

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can be generated internally and how much it should arrange from outside. Such
estimated amounts are used for preparing cash budget.
2. Assess cash flow from operating activities: It provides information about cash
generated from operating activities. It provides explanation for the difference net profit
and cash from operations. Cash provided by operating activities is very important to
assess the cash generated by internal sources.
3. Payment of dividends: Decisions to pay dividends cannot be based on net profit only.
Availability of profit in the form of cash is also important for dividend disbursement.
4. Cash from investing and financing activities: It provides information not only about
cash provides by operating activities but also by non-operating activities under two
heads, namely investing activities and financing activities. This helps to explain the
overall liquidity position of the enterprises and its ability to meet its cash commitments.
5. Explain reasons for shortage or surplus of cash: A business may have made profit and
yet running short of cash. Similarly a business may have suffered a loss and still has
sufficient cash at bank. A cash flow statement discloses reasons for such increase or
decreases of cash balance.

Advantages or importance of Cash Flow Statement

1. Planning and co-ordination of financial operations: It is useful in evaluating financial

policies and current cash position. Since cash is the basis for carrying operations, the
cash flow statement will enable the management to plan and co-ordinate the financial
operations probably.
2. A control device: It is also a control devise for the management. A comparison of cash
flow statement for previous year with the budget for the year would indicate to what
extent the resources of the enterprise were according to plan.
3. Useful to internal financial management: Since it gives a clear picture of cash inflow
from operations it is therefore, very useful to internal financial management in
considering the possibility of retiring long term debts, in planning replacement of plant
facilities or in formulating dividend policies.
4. Profit and cash position: It enables the management to account for situation when
business has earned huge profits yet run without money or when it has suffered a loss
and still has plenty of money at the bank.
5. Short term finance position: It helps the management in taking short term financial
decisions.

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Differences between Fund Flow Statement and Cash Flow Statement

Fund Flow Statement Cash Flow Statement

Fund means working capital
It is concerned with all items constituting
funds
It shows the causes for changes in working
capital
FFS is for a long term planning
There are no opening or closing balances in
FFS
Schedule of changes in working capital is
prepared
Fund refers to actual cash or cash inflow
It deals with cash transaction only
It shows the causes for the change in cash
CFS is a tool for short term financial planning
CFS starts with the operating cash balance and
ends with closing cash balance
Calculations of cash from operations is
prepared

Limitations of CFS

1. As the enterprise shifts form strictly cash basis, enters into credit transactions as well
takes into account prepared and accrued items, the net income no doubt would
generally represent an increase in working capital, yet equating net income to cash flow
for such enterprise would be inaccurate and misleading since a number of non-cash
items affect the net income of the firm.
2. The cash balance too easily influenced by postponing purchase and other payment.

Classification of cash flow

Cash flow from operating activities

Cash flow from investing activities

Cash flow from financing activities

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